Volcker Supports Popping Bubbles, Regulating Hedge Funds

In testimony today before the congressional Joint Economic Committee, Paul Volcker, who is chairman of President Barack Obama’s Economic Recovery Advisory Board, called for beefed up regulation to prevent future crises.

Volcker

Volcker repeated global regulatory objectives outlined by the G30, a nonprofit group comprising senior representatives of the public and private sectors and academia world-wide, in a report that he helped craft. “The G-30 Report recognizes what I believe is common ground among most analysts. Specifically, all banking organizations should come with the framework of an official safety net, with the natural corollary of regulation and supervision,” Volcker said.

However, he also mentioned some regulatory proposals that U.S. lawmakers and policymakers should consider.

The former Federal Reserve chairman weighed in on a debate over the role of government officials in popping bubbles. “The first and most fundamental lesson of the crisis is that future policy should be alert to, and take appropriate measures to deal with, persistent and ultimately destabilizing economic imbalances. I realize that is a large and continuing challenge of international as well as domestic proportions, but it is the essence of prudent economic management,” Volcker said.

He didn’t specifically mention the Fed, but discussion has been heating up over whether the central bank should act pre-emptively to pop bubbles. Volcker’s successor at the Fed, Alan Greenspan, famously stood against such a policy. “[T]he degree of monetary tightening that would be required to contain or offset a bubble of any substantial dimension appears to be so great as to risk an unacceptable amount of collateral damage to the wider economy,” Greenspan said in 2002.

However, in the last year Fed officials have been rethinking the policy. “[O]bviously, the last decade has shown that bursting bubbles can be an extraordinarily dangerous and costly phenomenon for the economy, and there is no doubt that as we emerge from the financial crisis, we will all be looking at that issue and what can be done about it,” current Fed Chairman Ben Bernanke said in October.

In June last year, former Fed Vice Chairman Alan Blinder weighed in on the debate, saying that the Fed could do more, but should be careful where and how it intervenes. “When bubbles are not based on bank lending, the mop-up-after strategy still looks pretty good. When it comes to bank-centered bubbles, however, there are many more things that a central bank can and should do. But raising interest rates to burst the bubble is probably not one of them,” Blinder wrote.

Meanwhile, in his prepared testimony Volcker also said that regulation should be expanded. “Banking organizations should be predominantly ‘relationship-oriented,’ providing essential financial services to individuals, businesses of all sizes, and governments. To help assure their stability and continuity and limit potential conflicts of interest, strong restrictions on risk-prone capital market activities — e.g. hedge funds, equity funds, and proprietary trading — would be enforced,” he said.

About Real Time Economics

Real Time Economics offers exclusive news, analysis and commentary on the U.S. and global economy, central bank policy and economics. Send news items, comments and questions to the editors and reporters below or email realtimeeconomics@wsj.com.